RBI broadens Rupee defence beyond dollar sales, turns to tighter monetary conditions: Report

The Reserve Bank of India (RBI) is widening its defence of the rupee beyond dollar sales, tightening monetary conditions to counter capital outflows and make bets against the currency more expensive, while avoiding the aggressive measures used during the 2013 currency crisis, a report on Reuters stated.

The RBI raised policy rates this month for the first time in four years and has drained liquidity through bond sales and tighter reserve requirements for banks and large foreign-exchange hedging transactions. The steps came as the rupee, down around 6% this year, neared its previous low of 96.96 per dollar. It has since recovered to 94.71.

Tightening across monetary conditions

“The central bank is in calibrated tightening mode and that means tightening across the board,” one source familiar with the RBI’s thinking told Reuters, adding that the bank would continue assessing whether further steps, including liquidity measures, were needed.

The RBI could discuss a 50-basis-point rate hike at its December policy review if inflation warrants front-loading increases, the sources said. The rupee swaps market reflects the possibility of a larger move, while HSBC and State Bank of India have also flagged a potential 50-basis-point increase.

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The RBI governor has said monetary policy cannot be entirely separated from financial stability, a shift from the bank’s earlier position that interest rates would not be used to defend the currency. Traders have since raised their rate-hike expectations.

Currency toolkit under pressure

Since March, the RBI has mobilised about $150 billion through measures to attract inflows, including a subsidised dollar-deposit scheme for the Indian diaspora. It has also reduced banks’ foreign-exchange position limits, imposed reserve requirements on large hedging transactions and supplied dollars directly to government oil companies.

Continued dollar sales have drawn down reserves, while the cost of betting against the rupee has risen to a five-year high. Domestic bond yields have increased by 45 to 60 basis points since early September. Between October 6 and October 15, the 10-year government bond yield rose from 7.19% to 7.39%.

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The RBI is unlikely to repeat the 2013 playbook of sharply raising the marginal standing facility rate, one source said, noting that the measure proved ineffective when banks had surplus liquidity.

Stability versus growth

Higher yields could improve returns on Indian debt and attract inflows, investors said. Overseas investors have sold nearly $33 billion of Indian equities this year and turned net sellers of debt since August.

However, rapid tightening risks slowing growth and raising borrowing costs. Nearly 60% of loans are linked to external benchmarks such as the policy rate, Reuters reported, allowing rate changes to pass through quickly. Analysts warned that using rates to support the rupee could add pressure to an economy already absorbing an energy shock, while policy must remain anchored to the inflation outlook.

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